First-time equity investors should bet cautiously

Excessive allocation to equities, or to mid and small-cap segment within it can cost you dearly

Investors from smaller towns are investing in mutual funds in a big way. According to data from the Association of Mutual Funds in India (AMFI), assets under management (AUM) from B15 locations grew 41 per cent year-on-year to Rs 3.09 lakh crore by the end of 2016-17. Meanwhile, with a one-year return of 21.67 per cent, the Nifty 50 is trading at a price-to-earnings (PE) ratio of 24.73. The Nifty Midcap 50 (PE 43.77) and Nifty Small cap 50 (73.92) are at even higher levels. With markets so bullish and valuations in the expensive zone, first-time investors from B15 towns clearly need to be cautious.

One mistake novice investors make in bull markets is to expect quick or short-term gains. Their expectations are based on their recent experience of making quick money from their equity investments. Often, investors then end up allocating excessively to equities. When the markets turn, such heavy concentration can cost them dearly. Decide on how much you will allocate to equities in your portfolio based on your investment horizon and risk appetite, and stick to it. Financial planners also suggest tying your investments to financial goals.

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"By defining your goals, you will know what time horizon you are investing for. Only money that you don't require over the next five years should go into the equity markets," says Amar Pandit, founder, HappynessFactory.in. Investors should also take into account their risk appetite when deciding on their equity allocation. "New investors have never experienced a bear market. They should think about whether they can tolerate a 20-30 per cent correction in equities," says Pandit (see table). 

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While equities may be performing well now, have an allocation to other assets like fixed income and gold. "Investors must stay diversified across major asset classes, irrespective of the market cycle. Long-term wealth creation is greatly influenced by asset allocation," says Vishal Kapoor, chief executive officer, IDFC Mutual Fund. If your allocation to equities has grown beyond the pre-decided level due to the run-up in the market, sell a part of your equity holdings and rebalance your portfolio. 

Investors also bet disproportionately on some asset class based on its recent performance, expecting those returns to be repeated. Says Swati Kulkarni, executive vice president and fund manager, UTI AMC: "The performance of mid- and small-cap indices has shown large divergence from that of large-cap indices,  leading to higher returns from mid- and small-cap funds compared to large-cap funds. This may lead to much higher allocation to a particular equity segment, which can be very risky. If that segment corrects sharply, investors may experience a high level of volatility." Diversify across market caps as well and rebalance your allocation to different market caps also periodically.

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Despite the markets being expensive, Kapoor suggests that you should continue to invest through systematic investment plans (SIPs) and systematic transfer plans (STPs) to get the twin benefits of regular investing and rupee-cost averaging. Stopping your SIPs tied to long-term goals could put those goals in jeopardy. Making lump-sum investments in these conditions can also prove costly. If the markets correct after you have invested, it could be years before your investments recover to their current levels.

Finally, don't head for the exit as soon as the markets begin to correct. "This is a mistake that new investors all over the world make. By doing so, they will deprive themselves of the long-term wealth creation potential of equities," says Jean-Christophe, director–investor solutions, Sharekhan.